US NEWS: Rule of confusion

The US Securities and Exchange Commission, Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve last month approved for comment the first draft of restrictions under the Dodd-Frank Act. However, rather than being a defining moment, the proposed restrictions, known as the Volcker rule, has wound up causing more confusion than clarification.

“It’s not written in a way that it can be a final rule at this point,” said Dan Meade, a partner in the Washington DC office of law firm Hogan Lovells. “No one’s happy with it.”

Meade would know, having recently rejoined Hogan Lovells after 15 months as senior counsel to the US House Financial Services Committee, where he was a principal draftsperson of the Dodd-Frank Act. He explained that some within the industry, such as banking entities that sponsor private equity funds, find the new rule named after former Federal Reserve chairman Paul Volcker to be too onerous. Others, such as consumer advocates, find it to be not strict enough.

Created to combat “systemic risk,” the major obstacle for banks is the 3 percent threshold to own and operate hedge and private equity funds, including those focused on real estate. Under the rule, banks must limit their investment in private equity to no more than 3 percent of their Tier 1 capital, with an additional restriction from acquiring more than a 3 percent ownership stake in any fund.

As it stands now, the new Volcker rule could severely limit the ability of banks with real estate investment platforms, such as Goldman Sachs, JPMorgan, Morgan Stanley and Deutsche Bank, to own or sponsor private equity funds.

“Regardless of how the final rule comes out, it’s pretty clear that banking entities won’t be able to rely on the 3(c)(1) and 3(c)(7) private equity exemptions to structure their real estate funds,” said Meade. However, “they may try hard to structure their real estate funds under the 3(c)(5) exemption, which isn’t covered by the Volcker rule.”

The proposed Volcker rule also is vague about rules concerning mezzanine debt funds. After all, lending is considered a core activity of most banks, and US regulators would be loathe to further reduce the already muted level of lending activity, particularly since they have spent the past couple of years and millions of taxpayer dollars trying to foster it. Some banks have had success with these types of vehicles and are eager to know the rule’s ultimate stance on them.

Some, however, believe the industry is nowhere near ready to speculate on the impact of the Volcker rule on banks in the private equity space. When asked about its possible effect, a Deutsche Bank spokesman told PERE quite simply: “We are studying the proposal, and it is too early to say.”

It may indeed be too early to say, as a final version is not slated to take effect until 21 July 2012. Until then, the SEC, FDIC and Federal Reserve are seeking comment in the hopes of addressing any industry concerns ahead of the implementation date.